Banks blindsided by former Bush official

Wall Street woke up with a new problem Tuesday: a Republican Goldman Sachs alum using his new bully pulpit atop the Federal Reserve to suggest the biggest banks should break up.

Serving up policy fuel in a populist election cycle where bank bashing is front and center, Federal Reserve Bank of Minneapolis President Neel Kashkari — who helped run President George W. Bush’s 2008 bank bailout plan — sounded a lot like Bernie Sanders and Elizabeth Warren when he outlined dramatic solutions to end “too big to fail.”

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"The biggest banks are still too big to fail and continue to pose a significant, ongoing risk to our economy," Kashkari said in in a speech at the Brookings Institution in Washington.

Sanders immediately issued a a press release saying he was "delighted" by Kashkari's remarks.

Kashkari is staking a claim that a handful of banks are still so entrenched in the economy that the government would bail them out in a meltdown. He argues that regulatory safeguards enacted by Democrats and President Barack Obama after the 2007-2009 financial crisis didn't go far enough. And Kashkari is going beyond where other policymakers in his shoes have been willing to go, suggesting the way to fix the problem might be breaking up the biggest banks or forcing them to hold so much capital that they become public utilities.

"There have been a number of regulators who have stated that we still have a too big to fail problem, but they have been reluctant to take that logical next step and say that we need to break up these institutions," Americans for Financial Reform Policy Director Marcus Stanley said.

Kashkari's plan shocked Washington's financial policy wonks and lobbyists who have spent years fighting over rules still being implemented from the 2010 Dodd-Frank law. Kashkari's unexpected campaign — in which he says there needs to be "transformational" change — has the potential to shake up the discussion among banks, regulators and politicians.

A big part of the surprise was that Kashkari, who ran for governor in California as a Republican in 2014 and has been at the Fed for less than two months, was taking on the issue. But he can make a compelling argument that he knows what he's talking about firsthand.

He served in the Treasury Department from 2006 to 2009, and at the end of his tenure in the Bush administration, he oversaw the financial crisis bailout known as the Troubled Asset Relief Program.

Kashkari said the lessons he learned during the financial crisis "strongly influence" his view on new regulatory measures aimed at ending too big to fail. Tools that Congress gave regulators to deal with the failure of large banks, such as "living wills" that banks are required to write, have the potential to work, but progress on them is "incomplete and slow moving," Kashkari said.

"No rational policymaker" would risk restructuring large firms and forcing losses on their creditors and trading partners in a risky environment, he said.

"They will be forced to bail out failing institutions — as we were" he said.

Kashkari's announcement made waves on the campaign trail, the Hill and K Street, though some bank lobbying groups are taking their time before going on the defensive against a top Fed official.

Tim Pawlenty, former governor of Minnesota who is now president of the Financial Services Roundtable, said regulations requiring larger reserves and decreased risk should be finalized and their impact studied "before policymakers can credibly call for them to be repealed and replaced with actions that could put American banks at a major global disadvantage and have other unintended consequences.”

John Dearie, acting chief executive of the Financial Services Forum, said breaking up global financial institutions based in the United States "would ensure that one of the U.S.’s most competitive global industries serving companies small and large is turned over to banks based outside the United States.”

While Kashkari earned praise from Sanders, he is entertaining ideas that appear to go beyond the comfort zone of former Secretary of State Hillary Clinton, who has run on a regulatory platform that's more focused on risks outside the traditional banking sector. Republicans haven't spent as much time digging into bank regulation and too big to fail in their debates.

A spokesman for the top Democrat on the Senate Banking Committee, Sherrod Brown, said the Ohio senator was "encouraged" that Kashkari was focusing on additional steps to address too big to fail.

"For too long too many people involved in creating or responding to the financial crash have remained silent about what happened and what really needs to be done, and that goes for Wall Street CEOs and policymakers," said Dennis Kelleher, president of Wall Street reform advocacy group Better Markets. "This is a refreshing and encouraging statement by an insider about the need to end too big to fail and the commitment to do something about it."

Kashkari said he plans to deliver a plan to Congress by the end of the year.